Why Understanding Unit Economics Will Help Your Venture Survive

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Improving people’s lives in emerging economies, while disrupting markets in a financially viable way, is the mission of many passionate entrepreneurs. In most cases as a general for-profit organization, the financial model starts to show modest growth in profitability in the second year of operations. However, this is even harder to achieve for a social venture. Most of the margins are so low (if not negative), and the business relies on scaling volume in a fragmented and uncertain market over a short period of time.

There is a greater responsibility to deliver more value when serving low-income customers. Tweet This Quote

At the same time, there is a greater responsibility to deliver more value when serving low-income customers. Therefore, it is important to know how much gross margin is made on a unit of product sold or customer served.

Through my experience building Ghonsla, an insulation solutions business in underserved areas of Pakistan, I have realized that unit economics have the power to dictate the future of a venture. Having demand of any level is great, but if you can’t demonstrate that the unit economics work early on, scale can’t be expected to solve the issue.

When talking about building traction, most entrepreneurs’ default response goes along the lines of “increase in revenue, customers served, products sold, jobs created, income generated”…and other proxy measures of social impact.

Having demand is great, but if you can’t demonstrate that the unit economics work early on, scale can’t solve the issue.Tweet This Quote

Unfortunately, the discussion around the unit economics of the business and the bottom line are postponed, only deliberated over when the realization hits of an increasing burn rate and need to seek the next round of funding.

Investors are increasingly requiring entrepreneurs to tune in more to the unit economics of their businesses and how these economics change with and contribute towards growth. While this nudge from investors is always welcome, the entrepreneur and team need to proactively embrace unit economics in order to truly understand if the business will survive to create an impact.

Here are three ways to be more deliberate about your venture’s unit economics that will help you avoid pitfalls:

1. Accept the dynamic nature.

While the Excel spreadsheet may show that the unit economics stabilize in the early stages of operation, they in fact change rapidly as you move from 0 to the first 100 customers to the first 1000 and so on. By the time my venture secured its first 100 customers, the minimum viable product needed a drastic shift. Local manufacturing was no longer viable.

By our next 200 customers, we needed to invest more effectively across the value chain to directly serve the customer instead of focusing on institutional customers. In this process, our assumptions about sales growth, pricing, costs and operating expenditures were constantly challenged. Accepting and understanding their dynamic nature provided the insight to pivot.

Accepting and understanding the dynamic nature of unit economics provides insight on when to pivot. Tweet This Quote

You must have a plan for a demonstrable reduction in variable costs, per unit fixed costs (due to sales growth), and a consistent operating expense/revenue ratio that creates a healthy net income to further fuel growth. Additionally, you must lower pricing when moving to mass markets.

2. Diligently simplify.

Even with the dynamic nature of unit economics, there are ways to simplify, benchmark and track performance. For more clarity, instead of aggregating costs (as fixed, variable or operational expense), try breaking down the functions of the value chain. Work to understand how much is being spent at the various stages to acquire, serve and retain a customer per unit of sales versus the value of the unit of sales.

Once this is more simplified, the more relevant discussions become of improving operational efficiency through investing in a certain technology or system, exploring franchising or outsourcing options, comparing with local competition, benchmarking against other similar global ventures, etc.

Even with dynamic unit economics, there are ways to simplify, benchmark and track performance. Tweet This Quote

3. Build ownership.

When the bottom line diminishes or is negative, a natural impulse is to increase price or make the team leaner. However, that still doesn’t address why continual losses occur. Generic KPIs such as increase in sales by X% are insufficient if the variations in pricing, costs of goods sold, etc. are resulting in a lower gross margin, and if the same operating expense is being used to drive a lower sales volume.

While the exercise of monitoring the unit economics on a monthly/quarterly basis is usually delegated to the CFO, all members of the team need to be aware and responsible. Each of our field units has targets relating directly to the unit economics and must calculate their own profit in loss on a bi-weekly basis, coming up with strategies that involve their entire team.

Improving the unit economics of your social venture can empower your team to take bolder action. Tweet This Quote

In short, understanding and being more proactive about improving the unit economics of your social venture can empower your team to take bolder action. This enables you to create lasting impact, justifying why your venture exists in the first place.

Author Zehra Ali

Zehra is the Founder and CEO of Ghonsla. Zehra graduated from MIT as a Mechanical Engineer specializing in Building Technology and with a Masters in Technology and Policy. She is passionate about improving the quality of life for people at every level of society, conserving precious environmental resources and creating green jobs.